CVSI : CV Sciences Stock Analysis and Research Report

2017-11-20 - by Asif

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CV Sciences was incorporated under the name Foreclosure Solutions, Inc. in the State of Texas on December 9, 2010. On July 25, 2013, the Company’s predecessor, CannaVest Corp., a Texas corporation (“CannaVest Texas”), merged with the Company, a wholly-owned Delaware subsidiary of CannaVest Texas, to effectuate a change in the Company’s state of incorporation from Texas to Delaware. On January 4, 2016, the Company filed a Certificate of Amendment of Certificate of Incorporation with the Secretary of State of the State of Delaware, reflecting its corporate name change to “CV Sciences, Inc.”, effective on January 5, 2016. In addition, on January 4, 2016, the Company amended its Bylaws to reflect its corporate name change to “CV Sciences, Inc.” The Company previously operated under the corporate name of CannaVest Corp. On June 8, 2016, the Company changed its trading symbol from CANV to CVSI, and continues to be traded on the OTC: QB.

The change in corporate name was undertaken in connection with the acquisition of CanX Inc., a Florida corporation (“CanX”). As more fully set forth in its Current Report on Form 8-K filed with the Securities and Exchange Commission on January 4, 2016 (the “CanX 8-K”), on December 30, 2015, the company entered into an Agreement and Plan of Reorganization (the “Purchase Agreement”) with CANNAVEST Merger Sub, Inc., a Florida corporation and a wholly-owned subsidiary of the Company (“Merger Sub”), CANNAVEST Acquisition LLC, a Delaware limited liability company and wholly-owned subsidiary of the Company (the “LLC”), CanX and the Starwood Trust, as the Shareholders’ Representative (the “CanX Acquisition”). Pursuant to the Purchase Agreement, Merger Sub merged with and into CanX with CanX surviving such merger. Immediately following effectiveness of the merger, CanX merged with and into the LLC with the LLC surviving such merger. Upon consummation of these transactions, CanX ceased to exist and all property, rights, privileges, powers and franchises of CanX vested in the LLC, and all debts, liabilities and duties of CanX became the debts, liabilities and duties of the LLC. In consideration for the acquisition of CanX and its wholly-owned subsidiary, Cannabine, LLC, a Florida limited liability company, the Company paid and issued to the former shareholders of CanX at closing an aggregate sum of $250,000 in cash and 5,000,000 shares of the Company’s common stock. Pursuant to the Purchase Agreement, subject to the Company achieving certain post-closing milestones, the Company was previously required to pay and issue certain additional contingent consideration to the former shareholders of CanX, as more particularly set forth in the CanX 8-K. As further discussed in the Current Report on Form 8-K filed with the SEC on March 22, 2017 (the March 2017 8-K), on March 16, 2017, the parties to the Purchase Agreement entered into an amendment to the Purchase Agreement pursuant to which the Company agreed to issue the additional contingent consideration without the Company having achieved the remaining post-closing milestones and agreed to certain revisions to the buy-out option of the Company for the royalty payments otherwise due to the former shareholders of CanX, as further discussed in the CanX 8-K.

Following the CanX Acquisition, the Company has two distinct business segments, a specialty pharmaceutical segment focused on developing and commercializing novel therapeutics utilizing synthetic Cannabidiol (“CBD”); and, a consumer product segment focused on manufacturing, marketing and selling plant-based CBD products to a range of market sectors.

Pharmaceuticals

The company's specialty pharmaceutical segment is developing synthetic cannabinoids to treat a range of medical conditions. Cannabinoids are compounds derived from the Cannabis sativa plant, which contain two primary cannabinoids, CBD, and Δ9-tetrahydrocannabinol (“THC”). Clinical and preclinical data suggest that CBD has promising results in treating a range of medical indications. The company acquired two product candidates in the CanX Acquisition, each utilizing synthetic CBD as the active pharmaceutical ingredient.

The Company’s first patent-pending product candidate, CVSI-007, combines CBD and nicotine in treatment of smokeless tobacco use and addiction. There are currently no drugs approved by the U.S. Food & Drug Administration (“FDA”) for treatment of smokeless tobacco use and addiction. The company believe this product candidate will provide treatment options for this significant unmet medical need. The Company is hopeful to be in a position to file an Investigational New Drug Application (“IND”) with the FDA in the future. The company expect to hold a pre-IND meeting with the FDA during the first half of 2017 to obtain guidance on this development program. CVSI-007 is based on proprietary formulations, processes and technology that the company believe are patent-protectable, with an application that expires in 2036.

Consumer Products

The company manufacture, market and sell consumer products containing plant-based CBD under its PlusCBD™ brand in a range of market sectors including nutraceutical, beauty care, specialty foods and vape. The company expect to continue to add new products to its PlusCBD™ portfolio to enhance its line of CBD and hemp-related consumer products. The company also expect to develop and launch new brands to more effectively market and sell certain products. The company also sell raw materials acquired by it through its supply relationships in Europe to various customers that produce products for resale into the market.

The company seek to take advantage of an emerging worldwide trend to re-energize the production of industrial hemp and to foster its many uses for consumers. Historically cultivated for industrial and practical purposes, hemp is used today for textiles, paper, auto parts, biofuel, cosmetics, animal feed, nutritional supplements and much more. The market for hemp-derived products is expected to increase substantially over the next five years, and the company believe CV Sciences is well positioned to be a significant player in the hemp industry.

The company expect to realize revenue to fund a portion of its working capital needs through the sale of finished products and raw materials to third parties. However, in order to fund its drug development efforts, the company will need to raise additional capital either through the issuance of equity and/or the issuance of debt.

Current Operations

Specialty Pharmaceuticals

The company currently contract with qualified parties and contract research organizations for its preclinical research and IND preparation and development. Commercialization of future specialty pharmaceutical products in the United States and other territories may rely on licensing and co-promotion agreements with strategic partners. If the company choose to build a commercial infrastructure to support marketing in the United States, such commercial infrastructure could include a sales organization, internal sales support, an internal marketing group and distribution support.

Consumer Products

The company utilize internal resources to manufacture, market, and sell products containing hemp-derived CBD primarily under its PlusCBD™ brand. Hemp-derived CBD is one of at least 80 cannabinoids found in hemp, and is non-psychoactive. The company's U.S. based operations oversee its raw material supply chain, raw material processing, product development and manufacturing, and sales and marketing. The company will continue to scale-up its processing capability to accommodate new products in its pipeline.

Description of its Subsidiaries

The Company owns 100% of the issued and outstanding membership interests of two subsidiaries: Plus CBD, LLC (formerly, “Global Hemp Source, LLC”) (“Plus CBD”), and the LLC. The Company also owned a 70% interest in CannaVest Europe, GmbH. On May 2, 2016, the Company filed Articles of Dissolution for its wholly-owned subsidiaries US Hemp Oil, LLC and CannaVest Laboratories, LLC (formerly, “PhytoSPHERE Systems, LLC”) with the Secretary of State of Nevada, effective as of April 29, 2016. On January 20, 2017, the Company filed for dissolution of CannaVest Europe, GmbH, an entity that prior to dissolution, the Company had a 70% interest in, with the District Court, Dusseldorf Germany, effective December 31, 2016. None of US Hemp Oil, CannaVest Laboratories and CannaVest Europe GmbH had any assets or liabilities at the time of their dissolution.

Inventory and Sales

Based on expected increasing demand, CV Sciences has invested significant capital to develop and maintain relationships with growers on a global scale to ensure access to raw materials to support anticipated revenue growth. The company source its raw materials from well-established and well-recognized hemp growers in Europe. CV Sciences has arrangements with some of these growers for exclusive rights to their supply. Despite this already large footprint, the company continue to explore and develop other relationships to ensure that the company can meet the expected demand for bulk hemp products well into the future. The company's current inventory levels are sufficient to support sales through 2017, resulting in reduced cash outflow for inventory purchases. In addition, the company do not intend to purchase raw inventory from its supply chain arrangements from the 2017 crop and/or 2018 crop. During the year ended December 31, 2016, the company recorded an impairment of inventory expense of $3,562,459 (See Note 4 of the Company’s consolidated financial statements).

Subject to applicable law, CV Sciences has initiated hemp research and development studies in the U.S. in Kentucky through partnerships with the Kentucky State Department of Agriculture and several universities, on a pilot scale.

Changes in the Law and Development Programs

For the first time since 1937, industrial hemp has been decriminalized at the federal level and can be grown legally in the United States, but on a limited basis. A landmark provision passed in the Agricultural Act of 2014 recognizes hemp as distinct from its genetic cousin, marijuana. Federal law now exempts industrial hemp from U.S. drug laws to allow for crop research by universities, colleges and state agriculture departments. The new Federal law allows for agricultural pilot programs for industrial hemp “in states that permit the growth or cultivation of hemp.”

Under the jurisdiction of the Agricultural Act of 2014, the company entered into two separate agreements during 2015. The company entered an agreement with the Kentucky State Department of Agriculture to complete research under pilot studies with farmers and processors of CBD. In addition, the company entered into an agreement with the University of Kentucky to fund research regarding cultivation techniques to increase CBD production. CV Sciences is also evaluating opportunities within Kentucky to invest in processing facilities and equipment in support of its consumer products business segment.

Market, Customers and Distribution Methods

The market, customers and distribution methods for hemp-based products are large and diverse. These markets range from hemp-based bio plastics to textiles. This is an ever-evolving distribution system that today includes early adopter retailers and ecommerce entities, and product development companies that use its PlusCBD™ brand oil to develop consumer products for distribution. The number of “mainstream” commercial and retail stores that currently stock and sell its products is increasing primarily through customer awareness. The company believe that as awareness grows for the “green”, environmentally-friendly products derived from hemp\cannabis, the consumer market will adapt its current product lines to integrate them with hemp-based additives or replace harmful components in their existing products with the components of hemp.

The company's target customers for its consumer product segment are first and foremost end consumers via internet sales, direct-to-consumer health and wellness stores, collectives, cooperatives, affiliate sales and master distributors. Secondarily, CV Sciences is targeting manufacturers of products that can readily replace their raw base materials for its base materials, making the products more environmentally friendly and sustainable. In the future, the company intend to target national and regional broker networks and major distribution companies who have preexisting relationships with major retail chain stores. In addition, CV Sciences is directly pursuing distribution opportunities with national retailers. As the company continue to develop its business, these markets may change, be re-prioritized or eliminated as management responds to consumer and regulatory developments.

Competition

There are several companies developing cannabinoid therapeutics for a range of medical indications. The cannabinoid therapeutic area currently includes formulated extracts of the Cannabis plant and synthetic formulations. These formulations include CBD and THC, or a combination of CBD/THC as the active pharmaceutical ingredient. Certain companies such as GW Pharmaceuticals, PLC have focused on plant-based CBD formulations; while other companies such as Zynerba Pharmaceuticals Inc. and Insys Therapeutics Inc. have focused on synthetic CBD formulations.

The CBD-based consumer product industry is highly fragmented with numerous companies, many of which are under-capitalized. The company routinely evaluate internal and external opportunities to optimize value for shareholders through new product development or by asset acquisitions or sales. There are also large, well-funded companies that currently do not offer hemp-based consumer products but may do so in the future.

Intellectual Property

CV Sciences has filed trademark applications on its brands, logos and marks including, but not limited to CV Sciences and Plus CBD. On January 30, 2016, the company received a Notice of Allowance from the U.S. Patent and Trademark Office for its utility patent application number 14/791,184, Novel Process for Generating Hemp Oil with a High CBD Content. This patent covers its solvent-free and highly repeatable process for producing hemp oil with higher concentrations of CBD and expires in 2033.

CV Sciences has a pending patent application for its product candidate CVSI-007 in the United States that will expire in 2037.

The company review its intellectual property portfolio on a periodic basis and the company will continue to broaden its portfolio in a fiscally prudent manner. The company intend to file for patent protection on its pharmaceutical products based on proprietary formulations, processes and technology.

Research and Development

The company opened a laboratory facility in San Diego, California in September 2013 to advance its CBD consumer products business. Research and development costs are charged to expense as incurred and include, but are not limited to, employee salaries and benefits, cost of inventory used in product development, consulting service fees, the cost of renting and maintaining its laboratory facility and depreciation of laboratory equipment. The company's lab specializes in process development and product testing. The company incurred research and development expenses of $1,159,009 and $1,320,003, for the years ended December 31, 2016 and 2015, respectively.

Source and Availability of Raw Materials

The Company sources its raw materials from well-established and well-recognized hemp growers in Europe. CV Sciences has arrangements with some of these growers to have exclusive rights to their supply. The Company has two supply arrangements in place with European farmers to supply raw material in future years. CV Sciences has contractual rights for the growth and processing of hemp oil for delivery through October 2018 under both contracts. The company do not intend to purchase any inventory under these supply agreements from the 2017 crop and/or 2018 crop. As such, the company recorded an impairment expense during the year ended December 31, 2016, related to acquired goodwill and intangible assets from PhytoSPHERE (See Note 7 of the Company’s consolidated financial statements). In addition, during the year ended December 31, 2016, the company recorded a $3,562,459 impairment of certain raw material inventory (See Note 4 of the Company’s consolidated financial statements).

Employees

As of March 23, 2017, the company had a total of 39 employees; 38 full-time employees and 1 part-time employee. CV Sciences has no collective bargaining agreements with its employees and none are represented by labor unions. Management believes the Company has good relationships with its employees.

PROPERTIES

The Company leases certain office space in Las Vegas, Nevada pursuant to a month-to-month lease agreement dated April 1, 2013, which provides for a monthly rent of $1,500. The landlord is a limited liability company of which a former director of the Company is the sole member.

On March 27, 2014, the Company entered into a lease for 5,325 square feet of office space in San Diego, California for a term of 39 months. The monthly base rent under the lease is approximately $12,250, subject to an increase of 3% annually. The lease allows for rent abatement allowing one month free rent following each 12 month period of paid rent during the term of the lease. The lease commenced on May 7, 2014, the date the Company took possession of the new space. On December 24, 2014, the Company entered into a new lease for a 4,966 square foot expansion of its San Diego office facilities. The term of the office expansion lease extends to August 2017 and includes monthly base rent of $12,247.

On August 13, 2013, the Company entered into a lease for approximately 2,400 square feet laboratory space in San Diego, California. The monthly base rent was approximately $4,200 per month for a term of 12 months. On April 1, 2014, the Company entered into an amendment to increase the amount of laboratory space under the lease and extended the term of the lease for one additional year through August 2015. This amendment increased the amount of lab space under lease to 3,276 and added storage space for an additional 887 square feet. The monthly base rent under the lease was increased to approximately $6,320 per month. On February 23, 2015, the Company entered into another amendment to again increase the amount of laboratory space under the lease and extended the term of the lease through December 31, 2016. This amendment increased the amount of lab space under lease to 4,345 square feet, and increased the monthly base rent under the lease to $7,798. On December 22, 2016, the Company entered into a third amendment to this lease which increased the monthly base rent under the lease to $8,397 and extended the term of the lease through July 1, 2017.

On May 13, 2014, the Company entered into a lease for approximately 5,000 square feet of warehouse space in San Diego, California for a term of 3 years. The base rent under this lease is $5,000 per month.

On November 1, 2016, the Company entered into a lease for warehouse space in Lexington, Kentucky for a term of 6 months, with an option to extend the rent period to October 31, 2017. The base rent under this lease is $2,979 per month.

The company believe that its existing facilities are suitable and adequate for the operation of its business, including its current production capacity. CV Sciences is currently seeking to consolidate its facilities.

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